Are giant U.S. companies a safe haven in today’s world? Many investors are acting like that way but portfolio manager Matt McLennan is skeptical.
Some of the so-called lords of the equity market, mostly mega-tech companies with pristine balance sheets, are increasingly seen as a safe haven in a world where the U.S. government continues to rack up $1.7 trillion annual deficits, threatening the degradation of the U.S. dollar and perhaps the Treasury bond market.
There are no certain answers, but that scenario was one of several posited by Matthew McLennan, co-head of the global value team and portfolio manager at First Eagle Investments. McLennan, who took over a portfolio managed by the legendary Jean-Marie Eveillard, noted that the U.S. economy was experiencing a profound paradigm shift where both political parties offer no solutions to annual fiscal budget deficits of 7.2%, levels one might expect in a deep recession, not in a relatively strong economic expansion.
One might anticipate that deficits at this stage of the growth cycle would be approaching a surplus, McLennan said at a press event on September 17. Instead, the U.S. “fiscal settings,” or budget parameters, are at least “4% away from where they should be.”
For much of the previous decade, the U.S. was able to run massive deficits with the benefit of near-zero interest rates, which caused policymakers to embrace some very bad habits. Over the long term, there is going to be greater linkage between fiscal policy and inflation, McLennan said. That’s something we may just be starting to experience, he said.
Then there is another segment of the economy that McLennan identified, the mega-cap tech companies he called the “equity lords.” In the talk, he referred to a 1995 novel, "The Diamond Age: Or A Young Lady’s Illustrated Primer," written by Neal Stephenson, who had quite the crystal ball. His novel addresses the rise of AI and hugely profitable tech giants, as well as the advent of the metaverse and digital currencies, to name a few futuristic developments.
McLennan observed that companies like Meta, Alphabet, Microsoft and Amazon seemingly operate in their own alternate universe. Even though these businesses are viewed as asset-light in Wall Street parlance, each shells out more in capital spending than an old industrial giant like Exxon Mobil.
While much of the manufacturing economy has suffered a slowdown or, in some cases, a downturn, since the Fed started raising interest rates, the giant equity lords operate in a world almost oblivious to economic cycles. They are extremely profitable and can finance themselves through either the sale of equity or debt. But like John D. Rockefeller's Standard Oil more than 100 years ago, a major challenge they face is what to do with their surplus cash. Most have started to pay dividends and are engaged in huge stock buybacks.
McLennan noted that one rarely sees profits go up when the economy is in a recession and, right now, it is these businesses and not the old smokestack companies that are driving the U.S. economy. All are innovative and display an unusual degree of resilience to the fluctuations of the business cycle and the global economy.
This world contrasts America dramatically against China, which is moving in an opposite direction, he said. The Shanghai stock market suffered a lost decade before the pandemic and things aren’t going any better today, McLennan continued. China is expanding its “autocratic” tendencies, turning the regulatory screws on its equity lords, along with private enterprise and individual liberties.
Meanwhile, in America, bipartisan “wariness” towards China is mounting, he said. Conversely, the Chinese view America as “imperialistic or territorial.” Like almost all of the developed world, both nations face difficult demographic challenges.
In McLennan’s view, fiscal challenges are “becoming globalized.” This may explain why both “equities and gold have peaked while the quality of money has declined,” he said.
While the S&P 500 and the price of gold continue to drift higher, real economic growth is rising but not nearly at a rate that covers the growth of debt, he noted. That’s why McLennan suggested that global financial markets could experience a “Liz Truss moment,” a reference to the British prime minister who came into office promising tax cuts in 2022 and lasted only 33 days in office as the U.K. gilt market collapsed after determining her proposal had no credibility.
McLennan said he is skeptical that the giant U.S. tech sector is a safe haven in this unstable world. If the U.S. and other developed nations running big deficits were to experience a debt crisis, “I would suggest it would be bad for all assets,” he said.